The causes of market volatility in 2018, the impact on asset classes and what this may mean for markets in 2019?
2017 turned out to be one of the best years for investors; 2018 on the contrary had investors on tenterhooks. While US markets advanced to new highs and then saw a 20% correction from these peaks, China continued to be in a bear market throughout the year. With the correction last year, equity risk premiums are significantly up across the world and investor sentiment has also taken a strong beating.
Tech & China slowdown: US markets were largely driven down by technology stocks as large companies like Apple gave weak forward guidance ahead of the quarterly earnings season, owing largely to growing signs of a Chinese economic slowdown.
Credit markets: The corporate debt market in the US deteriorated in 2018. A quarter of junk rated issues are now B– or lower, the highest level since 2009 (Source: S&P). Junk bond issuances were also down at the end of 2018 as yields increased. High yield spreads have risen substantially which is considered to be a leading indicator of volatility. We believe that the transition from quantitative easing (QE) to quantitative tightening (QT) is central to such cracks appearing in debt markets.
Yield curve: The US yield curve continues to flatten suggesting lower growth expectations and a maturing economic cycle. This could see equities continue to experience a volatile environment going forward, as flatter curves have coincided with higher levels of volatility as seen in the financial crisis period of 2007-08.
2018 was largely dominated by trade war issues and Federal Reserve policy concerns and we could now see US equities underperform other equity markets due to a reversal in recent divergent monetary policies. Much of the returns in the US over the last decade can be attributed to strong dollar performance and any weakness in the US dollar will serve as a strong catalyst for other equity markets’ relative performance going forward.
As and when the Federal Reserve takes a pause in tightening, other developed economies may stay on their course to tighten. This would mark the peak in the US dollar, which would have a significant impact on global assets’ performance. Global currencies from developed and emerging markets would be expected to appreciate relative to the US dollar. Given the 60% weighting to US equities in global market indices, consideration should be given to the make up of your equity portfolio.
With equity markets falling significantly in the fourth quarter of 2018, investors started to concern themselves with political issues and the impact on global economic growth. Markets began to focus on negative news flow and ignoring the positives, a reversal from recent years. With potential resolutions for trade conflict on the horizon, concerns could lift and equity markets could in turn thrive. As Warren Buffet once said “Be fearful when others are greedy and greedy when others are fearful”. Nonetheless, with a number of economic indicators showing slowing growth, risks remain and we continue to recommend diversification to increase resilience in a number of market scenarios.
For more information regarding the contents of this article, or our investment team, please contact your usual JLT Consultant. Alternatively, please contact Jignesh Sheth, Head of Strategy or Darryn Lake Chief Investment Officer, both in our Investment Solutions Team.